Friday, May 22, 2009

Nationalized and free markets

The NYT report this morning on the pre-packaged GM bankruptcy makes it clear that the Obama administration is going to force the Chrysler model of cramdown on the GM bondholders:

A coalition of small bondholders protested the terms of G.M.’s offer in Washington on Thursday. Larger, institutional bondholders have also opposed the deal, which calls for them to receive 225 shares of G.M. stock in exchange for each $1,000 worth of debt.

G.M., which is subsisting on $15.4 billion in government loans, has until June 1 to meet the broad criteria for restructuring spelled out by a special presidential auto task force.

Under a plan announced last month, the Treasury Department would control at least 50 percent of the stock in a restructured G.M. A health care trust for union retirees would have about 39 percent, with bondholders getting 10 percent and current shareholders the remaining 1 percent.

Advisers to a committee of G.M.’s biggest bondholders, representing about 20 percent of the $27 billion in bond debt, have repeatedly criticized the plan as unfair and designed to fail. They have also accused the government of seeking to use them as scapegoats for a potential bankruptcy filing. Under their own proposal, G.M. bondholders would own 58 percent of the reorganized carmaker. These advisers have said that they are willing to negotiate with the company and the government but have made no headway thus far.
Bankruptcy courts have given priority to the claims of creditors, not to keeping the company running. In the 2006 bankruptcy of Tower Records, the court chose a liquidation plan over a plan to keep the company running, because its bid was 0.3% higher and thus would give more money to creditors.

Now it is clear that there are two sectors of the American economy: one where the government will use its power to impose the solution it thinks best, and one where investment and the allocation of rights is governed by the rule of law.

Investors who put their money into the nationalized sector — whether in equities or bonds — have to realize that their rights as investor/lenders will be subordinated to the national government’s industrial policy. The business school term for this is “political risk,” normally referring to third world countries where the rule of law is not yet established.

In this case, people who bought Chrysler or GM bonds assumed they would be given preference in liquidation, but the rules changed with the new administration. Knowing what they know now, any Chrysler or GM bondholder should have sold their bonds on November 5 or even earlier.

There is no reason to think this is the last example of political risk under the new government’s policies. The intervention is normally justified in the name of helping struggling industries and saving jobs — which means autos and banking are nationalized sectors. Other industries are in deep trouble — newspapers, Hollywood, real estate — will these be nationalized too?

Where will the government draw the line? Energy is a central part of the administration’s new economic policies — will it be controlled the same way as the automakers and the TARP banks?

For every seller, there’s a buyer. Anyone buying such debt is hoping that there will be political pushback that stops the administration (unlikely) or that the economy has bottomed out and no more firms will be facing bankruptcy (also unlikely).

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